Smoot-Hawley Lives

This week we look into my worry closet and ponder whether the Dubai port debacle
is a one-off thing or does it signal a rise in protectionism. The recent polls
suggest I will upset about 90% of you, but I look at the deal from the very
negative economic impact it could have on this country. We then briefly look
at the potential for more Fed rate increases and at a disturbing Federal Reserve
Bank report on US wealth.

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Smoot-Hawley Lives

Long-time readers know that I do not think the world is going to devolve into
a soft depression because of the imbalances in our trade deficit and our large
and growing debt. Those will have to be dealt with, of course, but I think
it will happen in the normal context of the business cycle. A recession here,
a falling dollar there, and slower than trend average US growth over the next
5 years or so and we get to where the re-set button has been hit. It will not
be fun, but it will not be the end of the world. It is what I call the Muddle
Through Economy. I am actually quite optimistic about the investment opportunities
once we get through that period, with the usual caveats and asterisks.

But I have maintained for many years that the one thing that could change
my basic optimism is a new wave of protectionism. Senator Smoot and Representative
Hawley infamously sponsored a bill in 1930 that raised tariffs on a variety
of products in order to "protect" American jobs. Of course, the rest of the
world retaliated and soon we went from a recession into a global Depression.
Unemployment soared and all those jobs we "saved" went away.

Recessions are part of the business cycle. The Fed cannot stop one, try though
it might, nor can Congress write legislation outlawing recessions. And in the
main, and with a few exceptions, they have not on balance been all that bad.
One can make the argument that they are needed to correct imbalances and "irrational
exuberances" here and there. Typically, unemployment rises a few percent but
comes back in a few years, the stock market falls but comes back and profits
fall but go on to make new highs after the "reset" button is hit.

I am not trying to be cavalier. If it is your job or investment or profits
that get hit, it can mean some very long and sleepless nights. Been there.
Done that. But for the vast majority of US citizens, the last recession had
little effect. Unemployment never rose above 7%, and corporate profits came
back quite strong. The next recession may be worse, but it will end soon enough.
That is the way of the business cycle.

But while recessions are part and parcel of the economic cycle, it takes a
government to really mess things up and create a Depression. Show me a depression
(not a shorter term recession!) in a free society that was not the result of
government incompetence or some form of direct government involvement. You
can't. Usually they are the result of multiple and coordinated government groups
all working together to make things better and having the opposite effect.

Yes, I suppose you could say that Smoot and Hawley were just responding to
the zeitgeist of the times, that the voters were demanding their jobs be protected,
so that the American people got what they deserved, but Congress and the Fed
aided and abetted. President Hoover should have used a veto. For that alone,
he deserved to be defeated two years later.

This week, an updated version of Smoot and Hawley's Congress put together
a veto proof gaggle to stop the United Arab Emirates from buying a British
port management company that ran six of our nation's ports. Security was the
ostensible reason, but anyone who did their homework knows that national security
on any level was never at risk. This congressional tantrum bothers me on several
levels.

Our ports are run by a number of companies that are not US based companies.
Five ports have Danish firms running them, for instance. Two are run by the
Chinese. Basically these companies move freight. Pick it up here and put it
there. They have nothing to do with port security. Port security is the province
of US Customs and the Coast Guard. And they hire American union workers.

The U.A.E may be the largest non-US port service for the US Navy in the world,
based in Dubai. They are a solid ally and a voice of moderation and stability
in an area of the world where such is needed.

There is a process where foreign investments in the US that have security
implications are brought before the Committee on Foreign Investment in the
US or CFIUS. This governmental inter-agency group looks at the investments
and if one of them sees a red flag, they run it further up the command chain.
This was an investment that was thoroughly investigated and caused no concern
and it was approved. And then some politicians saw an opportunity for political
gain.

Now, someone in the administration at the middle levels should have seen the
political implications of this deal. Sadly, the Bush administration does not
do a good job of explaining their policies. This should have privately been
run up to Congress and vetted there before the approval went through. So, a
lot of the blame should be laid onto the Administration for having a "tin ear."

Bi-Partisan Idiocy

The next thing we know, talk radio is going over the edge, calls into Republican
congressmen are running 9-1 against the deal in an election year that looks
tough for them to begin with, Democratic Congressmen see a chance to appear
concerned about national security and really tweak the President and before
you know it, there is a move to stop the deal.

There is a reason for the CFIUS process. It works and it keeps politics more
or less out of business deals. But now, Congress has learned it can basically
look at any deal and say it is against the national interest for some foreign
company to buy a US company. And every tin pot congressman who wants to posture
in front of a camera and who has a company in his district that becomes a target
will now want to get involved. Companies that lose a bidding war or that have
an axe to grind will complain to Congress. "I don't want that foreign company
competing on my turf and taking US jobs from my employees!" Shades of Smoot-Hawley!

We have spend decades persuading nations around the world to open up their
countries to investment. And they have. We have over $10 trillion invested
outside of the US, which made American firms $500 billion last year, a little
under 5% of our GDP! That is about $1,600 for every man, woman and child in
the US. (WSJ) That money gets paid out as dividends, gets invested in our economy
and goes to pay our workers.

Last year, foreigners increased their investments in the US by $1.4 trillion,
in a wide variety of investments. Without those dollars, the US dollar would
have collapsed, interest rates would be through the roof and we would be facing
(or in!) a REAL recession, not the garden variety ones we have had since 1990.

"A study by the Organization for International Investments finds that about
5.3 million Americans are directly employed by foreign owned firms with wages
averaging $63,000, or about 50% more than the average US wage. Foreigners are
not buying up America's wealth; they are investing in ways that add to it." (WSJ)

That means that about 8% of American workers are employed by foreign owned
companies. You can bet they are happy they have the higher paying jobs. If
not, they would simply leave. But the line for those high paying jobs is long.

But now, there are those in Congress who would like to stop that wealth and
job creating foreign investment.

"In recent weeks Members of Congress have suggested that the foreign-ownership
ban should apply to roads, telecommunications, airlines, broadcasting, shipping,
technology firms, water facilities, buildings, real estate and even US Treasury
securities." (The Wall Street Journal editorial, March 10, 2006)

How does this sound to those nations that we are trying to get to open up
to US investments? Why should they cooperate id we re not going to practice
what we preach, when it is in our clear interest to do so?

If this was just the U.A.E. deal, I could rest easier. But last year it was
the dust-up over China buying a mid-size US oil company that had relatively
little US production. We have Senators Charles (Smoot) Schumer and Lindsey
(Hawley) Graham cooperating in a bit of bi-partisan idiocy to try and put a
27% tariff on Chinese goods.

And let's be blunt. To suggest such a thing demonstrates either astounding
economic ignorance or simple political pandering of the worst kind. Probably
both. Do we really want to raise the price of everything from China by 27%?
On items that we no longer make here? Do we want to risk the start another
trade war? Or have the Chinese stop buying US Treasuries? Can you say recession,
boys and girls?

The Rise of Economic Nationalism

But it is not just the US where economic nationalism is on the rise. Good
friend and uber-pessimist Bill Bonner writes yesterday:

"The votes are in...the House Appropriations Committee voted 62-2 to bar Dubai
Ports World, a United Arab Emirates backed company, from holding contracts
at U.S. ports.

"'This is a national security issue,' said Rep. Jerry Lewis, the chairman
of the House panel, adding that the legislation would, 'keep American ports
in American hands.'

"Well, as patriotic as that sounds, the London-based Peninsular & Oriental
Navigation Company previously owned the five U.S. ports in question. Last we
checked, London was in Great Britain, not America. And what about the other
foreign-operated shipping terminals in the United States? China already runs
a terminal at the Port of Los Angeles and Singapore runs terminals in Oakland...are
we going to shut those down?

"Another major detail the House seems to have conveniently overlooked - the
UAE are our allies. U.S. Navy ships call at the port of Dubai, and the U.S.
Air Force uses UAE airfields to launch missions into Iraq and Afghanistan.
In addition, the UAE donated $100 million to Katrina relief - more than four
times any other countries contribution combined.

"'Not only in the United States, but abroad as well. We have the French government
trying to block an Italian bid for Suez. We have the Spanish government trying
to block a German bid for Endesa. We have the Polish government trying to quash
an Italian takeover of a German bank because it involves Polish subsidiaries...

"'This is starting to sound like a joke. But it's real and a new global depression
hangs in the balance. The more governments push, the closer we get to the edge
of a very mean cliff...'"

If there are national security concerns about a foreign investor, I am all
for blocking a deal. But short of that, when you get a government meddling
in the free market, the real loser will be the investors and workers in that
country. There is a reason that much of the rest of the developed world grows
at a much slower pace than the US. But it seems Congress is going to try and
fix that. If some members had their way, we could really slow things down!

The need for politicians to show their constituents they are "concerned" is
very large. So now that politicians have seen that foreign investing is a "hot
button," my first concern is that Congress for purely political reasons will
try to put their nose into every deal involving foreign investment, slowing
the wheels of commerce. The foreign company has no votes in the district, but
a call to protect American jobs or companies sounds all too reasonable to the
average voter who has no more understanding than the average congressman about
how the world economy actually works - about how foreign investment is critical
to our economic well-being. That will drive down bids for US property of all
sorts, as what foreign entity will want to put itself through that emotional
wringer, not to mention the extra cost?

Secondly, I am concerned about the lesson we are sending to trading partners
around the world. It is ok for Americans to invest in your countries and sell
your products we make here, but you cannot do the same? These things get emotional
all too quickly, witness the short fuse on the U.A.E port deal.

The Bush administration needs to become much better at making the case for
free trade. Where is free trade Bill Clinton when you need him? Oh, he was
literally advising the U.A.E. (who pay him hundreds of thousands for speeches)
on how to deal with the port issue while his wife was calling for the deal
to be stopped. Memo to Bill: call home every now and then and coordinate policy
with the next Clinton about to run for President. And maybe tell her why free
trade is a positive for the country. She has a better than running shot at
being president, so that is important.

And finally, I am very concerned about the message this sends to the Islamic
world. This note from George Friedman of Stratfor came in about 6 pm tonight
while I was writing, which briefly and eloquently analyzes the problem.(Stratfor
is my main source for international political analysis. www.stratfor.com.)

"The United Arab Emirates (UAE) state-owned firm Dubai Ports World (DPW) reacted
to opposition from the U.S. Congress by announcing March 9 it would transfer
control of six U.S. ports to a U.S-based entity. The next day, U.S. President
George W. Bush said he was concerned about regional fallout from the way in
which DPW was forced to back down. Bush said the deal's failure could send
a broader message to U.S. allies in the world, particularly in the Middle East,
and added that to win the 'war on terror' Washington must strengthen its ties
with moderate Arab countries in the Middle East.

"Bush is right about the repercussions this development could have on U.S.
interests at a time when Washington is trying to prosecute its war against
jihadism and when relations between the West and the Islamic world continue
to deteriorate. Though governments in the Persian Gulf region and beyond --
including the UAE -- will remain U.S. allies, the port deal's death will enhance
anti-U.S. and anti-Western sentiments among the people. Radical and militant
Islamists can manipulate those sentiments, raising the probability of violence
in countries prosperous and stable enough to have resisted radical Islamist
and jihadist impulses thus far.

"It should be noted that the UAE is among the few places in the Middle East
that comes close to resembling a Western country. It is one of the few countries
in the region that might qualify as a U.S. ally on a standard other than energy
and security.

"Radical Islamist activists and jihadist operators, in an effort to gain a
foothold in such countries, will try to take advantage of the situation by
arguing that no amount of wealth or cooperation will make them respected in
the eyes of the United States or the West. These Islamists likely will convince
many that moderation and alignment with the West has not paid off because the
West will always look down on Arabs and Muslims. They will also try to promote
the view that in the end, the West will always view Arabs and Muslims -- whether
radical or moderate -- as the proverbial 'other.'

"This propaganda will feed on existing frustrations and anger against the
West because of the invasions of Afghanistan and Iraq, the Quran desecration
scandal, the Abu Ghraib torture scandal and the recent controversy over cartoons
of the Prophet Mohammed. Resentment against the West for being anti-Islam and
having anti-Muslim prejudices runs deep and wide in the Muslim world, beyond
the Islamist and jihadist spheres of influence. Even mainstream and secular
Muslims will view the UAE port deal reversal as an example of an 'Islamophobic'
attitude gaining ground in the United States and Europe.

"Most Muslims will not resort to violence, but the growing anger and frustration
increases the potential recruiting pool for al Qaeda and other jihadist groups.
Consequently, countries like the UAE, Kuwait and Qatar, where political stability
and economic prosperity have kept radical ideologies from taking hold, could
become insecure. Thanks to the law of unintended consequences, the port deal's
failure will result in an increased security threat -- which was the raison
d'etre for opposition to the deal."

My hope and actual belief is that this will simmer down. I remember the same
talk in the 70's and 80's as the Japanese started buying so much of American
real estate. Remember the outcry over Pebble Beach and the Rockefeller Center?
Hopefully, this too shall pass.

But if things keep going on this trend, we will look back from the dark times
and point to this deal and realize this is where the lights started to go out.
Shame on us.

How Far Will the Fed Go?

New York Federal Reserve President Timothy F. Geithner hinted that the Fed
may have to raise rates even more because of the growing economy. "To the extent
that these forces act to put downward pressure on interest rates and upward
pressure on [stock, real estate and other asset] prices, they would contribute
to more expansionary financial conditions ... the Fed might have to act to
offset these effects." (Washington Post)

He went on to say there are reasons for low level of long term interest rates
such as foreign investors buying US government debt, slower growth in the rest
of the world and low inflation. Thus, he seems to be saying that the flat yield
curve is not sending a warning signal.

Geithner is a voting member and the vice-chairman of the Fed Open Market Committee.
What he says matters. This sounds like a man who is not convinced that one
or two more rate increases will be enough, or that an inverted curve will be
a problem.

With the recent increase in longer term rates, I think this will give the
Fed the feeling they have room to raise rates without significantly inverting
the yield curve. I continue to point out that the historical propensity for
the Fed is to raise rates too much. It takes about a year for rate increases
to really have an effect.

The Wealth of the American Nation

Americans are clearly the richest people on earth. Or are they? With some
$50 trillion in stocks, bonds and real estate, we are watching our net worth
grow each year. Some argue that the low US saving rate is not a problem as
real net worth is growing fairly rapidly.

But not for the average family. A survey by the Federal Reserve Board's Survey
of Consumer Finances offers us the most detailed recent look at the balance
sheet of U.S. households.

The median family has about $3,800 in the bank, do not have a retirement account,
has a home worth $160,000 with a mortgage of $95,000. No mutual funds, stocks
or bonds populate their investment portfolios. They make (jointly) $43,000
and struggle to pay off their $2,200 in credit card debt. That means 50% of
Americans are in worse shape than the above. It is not a pretty picture.

As I noted last week, "...we find that 67% of the people aged 50-64 saved
less than $10,000 last year. Over 40% saved less than $1,000!!!" No wonder
that most people expect to work after age 65.

March Madness Comes Home

ORU did in fact win their conference tournament, so my daughter, the captain
of the cheerleaders at ORU (he says proudly), will get to do her thing at least
one NCAA tournament game. They will get to be the sacrifice for some #1 or
#2 seed, but they did make it to the show. Dad hopes it will be at a city that
is easy to get to. Both twins will be home next week for Spring break, although
Amanda will have to go back early to go with the team to wherever they play.
And Abigail is bringing that special guy to spend the week. (Sigh, they grow
up so fast.)

It will be a busy week. Monday is oldest daughter Tiffani's birthday, and
the clan will gather. Tuesday we will watch the Dallas Mavericks play Cleveland.
Should be fun watching Dirk and LeBron go at it. Then hopefully ORU will play
its game in Dallas and not Dayton, so I will not have to get on a plane.

This week has been quite busy. In addition to the usual work, I am really
doing a lot of reading and research on the next book. It is quite a lot of
fun, actually. The world is going to be an interesting place in 20 years, and
trying to figure out how we get there is a real challenge.

Note: John Mauldin is president of Millennium Wave Advisors, LLC, (MWA)
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